Article

Factual Summary: Shipbuilder contracted to construct two 57,000 DWT bulk carriers, Hulls No. GY402 and GY404, the contracts for which were novated to Buyer. A dispute over the contract for Hull No. GY404 led to this litigation. The price of USD 41,250,000 for this vessel was payable in 5 installments.

Article 3(b) of the contract provided that Shipbuilder "shall notify with a telefax notice to the Buyer stating that the 1st 300 mt of steel plate has been cut in its workshop approved by the Buyer's representative and demand for payment of this instalment". The Contract also provided that the installment payments were to be refunded if the Contract was rescinded or cancelled.

A Refund Guarantee for the first installment was issued by Shipbuilder's Bank whereupon Buyer paid the first installment.

To obtain financing from Buyer's Bank, Buyer assigned to it all claims and monies due under the shipbuilding contract as well as the Refund Guarantee and notified Shipbuilder which acknowledged the notice. Subsequently, Buyer's Bank issued a Payment Guarantee for the first installment.

The second installment of USD 10,312,500 was to be paid by means of a "letter of guarantee" within five New York banking days of receipt by Buyer of a "Refund Guarantee" in a form annexed to the contract as Exhibit A and a certificate of cutting of the first steel plate. At Buyer's request, Buyer's Bank issued its Payment Guarantee to Shipbuilder for the second installment.

Claiming that the first cutting occurred on 18 April 2009, Shipbuilder invoiced Buyer for the second installment, attaching a certificate signed by Shipbuilder and a Bureau Veritas surveyor but not by the Buyer which claimed that it had not received adequate notice of the cutting to enable it to be present.

Subsequently, Shipbuilder demanded payment on the Payment Guarantee which Buyer's Bank refused.

Due to various disputes including whether the first cutting actually occurred and whether the Refund Guarantee for the second installment was satisfactory, the Shipbuilder and Buyer each claimed that the other had repudiated the contract and commenced arbitration. Shipbuilder sued Buyer's Bank for wrongful dishonor of the Payment Guarantee, contending that it was "in the nature of a demand or performance bond[,] [in which] [p]ayment is due upon a written demand, whether or not the payment which the bond 'guarantees' is actually due by the Buyer to the [Shipbuilder]." Buyer's Bank, on the other hand, contended that its undertaking was "a guarantee properly so called" and that any payment was contingent on determination of the substantive issues being arbitrated.

Shipbuilder moved for summary judgment. The trial court denied the motion, ruling as a matter of law that the undertaking of Buyer's Bank/Guarantor was a traditional suretyship undertaking, but was reversed on appeal.

Legal Analysis:

The Trial Court: The Trial Judge surveyed the legal and practical nature of undertakings used to assure performance, starting with a suretyship undertaking. He noted that "[t]he obligation of a guarantor is to be responsible for the contractual performance due by another person to a third" and categorized various types of guarantees including an undertaking to see to it that the principal performs and to answer for breach of contract if it does not (so-called "see to it" guarantee), an undertaking by the guarantor to pay if the principal does not giving rise to an action for debt, or an undertaking to pay on receipt of notice or information.

Noting that "English law affords a guarantor under a guarantee of the classic type a considerable degree of legal protection", the Trial Judge observed that the guarantor "may avail himself of all the defences available to the debtor in respect of the payment sought" in addition to any variation of the underlying contract such as an extension. The Trial Judge also recognized that due to the availability of these defenses, "guarantees habitually contain clauses intended to secure that the efficacy of the guarantee is not prejudicially affected in this way." Under these guarantees the Trial Judge observed that where there is a dispute, a determination that damages are owed usually depends on a decision of liability by a court.

The Trial Judge then stated:

"Hence the practice has developed, now well established, of having payment guarantees that are not guarantees, properly so called, but instruments-often called demand bonds or performance bonds-by which a bank or similar institution promises to pay an instalment due against a written demand, or a written demand accompanied by certain documents such as a certificate from the seller or a third party as to the occurrence of certain events, the presentation of such documents being the only condition of payment. If they are presented the Bank is obliged to pay, unless there is fraud. This is so even if there is a dispute as to whether the instalment is truly due. Liability arises from the instrument rather than the underlying contractual arrangement. An instrument of this kind is akin to a letter of credit in that the bank is concerned only to see whether or not the documents produced are those for which the instrument calls.

. . . .

In practice the beneficiary of a demand bond is likely to be able to obtain summary judgment if he is not paid on presentation of conforming documents even though there is a bona fide dispute as to whether the sum in question is due; whereas for the beneficiary of a guarantee the opposite is the case (unless it is clear that the defence is unrealistic)."

To avoid confusion in the use of terms, the Trial Judge used the terms "guarantee" and "demand bond" while recognizing that "[t]he language of business and banking does not adopt such distinct categorization. Instruments are often described as guarantees which are not guarantees properly so called."

The Trial Judge then reviewed cases and treatises that attempted to categorize various undertakings, identifying "a number of features [which] have been treated as indicia that the instrument under consideration falls into the one category rather than another" while noting that few are determinative, that the exercise cannot be given a "tick box approach", and that "the same factor, e.g. the description of the instrument as a guarantee, may have a different significance from case to case".

Among the factors noted were the assumption with which the court began as to whether the undertaking at issue was a demand bond or a guarantee, leaving it to the party challenging this assumption to prove otherwise, that the use of the term "guarantee" is not decisive, that weight should be given to the formula that "[Guarantor] is to pay on 'first written demand' supported by a particular declaration as the only condition of payment the instrument is likely to be treated as an obligation to pay, upon that demand, the amount specified regardless of the underlying position as between seller and buyer", whether it is issued by a bank, whether it contains clauses excluding or limiting defenses, whether payment is to be made against a certificate, whether there is a conclusive evidence clause, whether the format is similar to undertakings that are accepted as suretyship or demand bonds and the terms of the underlying contract regarding the undertaking, and whether the wording is appropriate to a secondary obligation.

Shipbuilder argued that the international character of the undertaking, its issuance by a bank, the statement that it is payable "on demand", and the absence of clauses limiting or excluding defenses available strongly suggested that the undertaking was a demand bond. Moreover, Shipbuilder suggested that the requirement of a certificate was the equivalent of a certificate of default. It also stated that the reference to an irrevocable, absolute, and unconditional guarantee "as the primary obligor and not merely as the surety" were consistent with its character as a demand bond as were the references to the obligation not being affected by underlying disputes.

In concluding that the undertaking was a suretyship guarantee, the Trial Judge stated "if the [Shipbuilder] wanted the additional security of a demand bond I would have expected it (i) not to use what was (a) described as, (b) took the form and used the language of, and (c) included provisions habitually found in, a guarantee; and (ii) to have used, instead, appropriate (and terser) language to make it clear that that was so." He gave weight to the following factors:

1. It was continuously referenced as a "Guarantee", a factor which was "far from conclusive ... [b]ut ... a pointer"

2. The name of the undertaking in the exhibit to the Contract is the same as that of the Refund Guarantee which is expressly dependent on the outcome of the arbitration.

3. The "core obligation" contains "the classic language of a guarantee."

4. The references to an irrevocable, unconditional, and absolute undertaking beg the question of what is irrevocable, unconditional, and absolute.

5. The reference to the undertaking being primary "and not merely as surety" "does not automatically mean that the instrument is not a guarantee".

6. It required a certification of cutting of the steel plate countersigned by Buyer which suggested to the Trial Judge that the undertaking could not have been intended to be a demand guarantee whose payment could be frustrated by Buyer's refusal to countersign. The Trial Judge rejected Shipbuilder's argument that these terms were without effect.

7. The reference to interest being due from the "first day after the date of instalment in default" is "difficult to reconcile with a free standing obligation to pay interest from any given date or following demand."

8. The Trial Judge opined that the provision for immediate payment on first written demand after a 20 day default "is an indicator of a demand bond" which would be "very strong" had the undertaking stated nothing more but is seriously undermined by the other factors.

9. References to the nature of the default in the underlying contract "well beyond what was needed for the purpose of identifying the obligation for which security was given."

10. The statement that "the [Shipbuilder] is not required to commence an arbitration against the Buyer in order to obtain payment from [Guarantor]" is "unnecessary (although it could be regarded as confirmatory) since the [Guarantor] has a primary liability."

11. The statement that Guarantor's obligation is not affected by disputes between the Shipbuilder and Buyer or delays in construction or delivery do not:

"signify (and they do not say in terms) that it is not open to the [Guarantor] to contend that the conditions specified in the Shipbuilding Contract and clause (2) of the Payment Guarantee for the 2nd instalment to become due have not occurred, i.e. that it is not open to the [Guarantor] to contend that there has been (a) no Refund Guarantee; (b) no cutting of 300 mt of steel plate and (c) no countersigned certificate."

Moreover, the provisions regarding defenses "ensure that the [Shipbuilder] is not at risk of having the guarantee rendered inoperative because of one or more of the classic reasons (variation or extension of time) why at common law a guarantor may be discharged."

12. The Trial Judge did not regard the role of the Guarantor in financing the shipbuilding contract as "providing, in the present case, any particularly sure guide to the correct interpretation." He also noted:

"Banks are used to providing performance bonds with all that that entails. . . . But banks also provide guarantees (including guarantees to pay on demand) and it may be in their interest to limit their obligation to that. What they have undertaken must largely depend on what they have provided for in the relevant document."

Appellate Court: On appeal, the appellate court reversed. Longmore, L. J., framed the issue as "whether a payment guarantee is a guarantee, properly so called, or an 'on demand bond', as it is called in banking terminology." Shipbuilder/Beneficiary argued that it was "in the nature of a demand or performance bond" under which "[p]ayment [was] due upon a written demand, whether or not the payment which the bond 'guarantee[d]' [was] actually due by the Buyer to the [Shipbuilder]." Guarantor contended that "the instrument [was] a guarantee properly so called. If the Second Instalment was and is not due, there [could] be no liability under the guarantee." Accordingly, Guarantor argued that payment was not due until the dispute about the installment reached a resolution. The appellate court concluded that the undertaking was an on demand guarantee.

Longmore listed arguments in favor of each result, stating that the decision was "not . . . particularly easy". Rejecting the notion of counting points, the appellate Judge noted "a presumption that, if certain elements are present in the document, the document will be construed in one way or the other." Seeking such a presumption, the appellate Judge looked to Paget's Law of Banking (11th ed.) under the topic "Contract of Suretyship v. demand guarantee". He found the following words, which he stated were "fully justified by the Court of Appeal authorities":

"Where an instrument (i) relates to an underlying transaction between the parties in different jurisdictions, (ii) is issued by a bank, (iii) contains an undertaking to pay 'on demand' (with or without the words 'first' and/or 'written') and (iv) does not contain clauses excluding or limiting the defences available to a guarantor, it will almost always be construed as a demand guarantee."

Looking to the transnational role of demand guarantees, the appellate judge noted:

"The fact is that guarantees of the kind before the court in this case are almost worthless if the Bank can resist payment on the basis that the foreign buyer is disputing whether a payment is due. That would be all the more so in a case such as the present when the Buyer can refuse to sign any certificate of approval which may be required by the underlying contract."

The appellate Judge criticized the trial Judge, believing he should "have had much more regard to the presumption than he did." Moreover, the appellate Judge noted that the undertaking was "to some extent drawn up by persons not entirely familiar with the English language" and based on prior forms. The appellate Judge observed:

"In these circumstances it is not in my judgment right to treat the words with similar reverence to the reverence with which one would construe a statute. It is much better (and indeed simpler) to be guided by the general tenor of previous authority enunciated by past judges of great distinction."

Comment(s):

1. These two decisions, both compelling but reaching different conclusions, exemplify what is wrong with demand guarantee practice. It is not just a name ("guarantee" means just what?) but also an entire culture of practice and law. It is shocking that the characterization of an undertaking of this magnitude involving serious commercial players and banks would have to be litigated and that the courts would reveal, as they did here, that they are clueless and left to guessing. This issue should have been resolved by the nature of the undertaking itself and the words used. Indeed, it is difficult to grasp the real issue, whether or not the undertaking is independent, from all the verbiage in the opinions.

2. Since so much money is involved, it is likely that we have not heard the end of the story. We may next hear the take of the English Supreme Court on this undertaking.

3. Instead (and here the lawyers are due much of the blame) of using the simple format of an undertaking to pay on the presentation of required documents, the drafters throw words at the reader, none of which have any compelling meaning. An undertaking that is irrevocable, absolute, and unconditional is not necessarily independent. In fact, an undertaking that is truly "unconditional" is not an independent guarantee since that undertaking is conditioned on a documentary presentation (as is a suretyship undertaking which is conditioned on the occurrence of facts). Moreover, a surety can be "primarily liable" to the beneficiary. That the liability is "not merely as a surety" suggests that it is at least as a surety. That there is a notice to be given is not unique to independent undertakings.

4. There are a variety of ways to address the mess of current practice: one is to presume that an undertaking that has some features of independence should be deemed to be independent, leaving it to the guarantor to make it clear that it is dependent. The other is to presume that the undertaking is dependent unless it clearly is not. Then there is the weighing of factors, an approach taken by both courts with differing results.

5. The real lesson here, however, is for beneficiaries: it is not to trust that attorneys know what they are doing and not to trust that bankers will provide an unambiguous undertaking. The real lesson is that beneficiaries should abandon the entire confused product and opt for standby letters of credit. While not foolproof, it takes considerable effort to make one into a dependent undertaking. What if the applicant resists? All the more reason to be suspicious and insist on a clear cut undertaking that will not run into this confusing analysis.

TEXT: As reprinted in the opinion, the Guarantee provided:

"DETAILS OF GUARANTEE Dear Sirs,

(1) In consideration of your entering into a Shipbuilding Contract dated 29th November 2006 ("the Shipbuilding Contract") with Tamassos Navigation Ltd as the buyer ("the BUYER") and WUHAN Guoyu Logistics Group CPM LTD and Yangzhou Guoyu Shipbuilding Co. Ltd as the seller ("the SELLER") for the construction of one (1) 57,000 Metric Tons Deadweight OEC known as YANGZHOU GUOYU SHIPBUILDING COMPANY LTD. HULL NO. GY404 ("the VESSEL"), we, EMPORIKI BANK OF GREECE SA, hereby IRREVOCABLY, ABSOLUTELY and UNCONDITIONALLY guarantee, as the primary obligor and not merely as the surety, the due and punctual payment by the BUYER of the 2nd instalment of the Contract Price amounting to a total sum of United States Dollars 10,312,500.00 (Ten million three hundred twelve thousand five hundred only) as specified in (2) below.

(2) The Instalment guaranteed hereunder, pursuant to the terms of the Shipbuilding Contract, comprises the 2nd instalment in the amount of U.S. Dollars 10,312,500.00 (Ten million three hundred twelve thousand five hundred only) payable by the BUYER within five (5) New York banking days after completion cutting of the first 300 MT of steel plate in your Seller's workshop and written notice thereof along with certificate of cutting of steel plate countersigned for approval by the Buyers representative.

(3) We also IRREVOCABLY, ABSOLUTELY and UNCONDITIONALLY guarantee, as primary obligor and not merely as surety, the due and punctual payment by the BUYER of interest on the second Instalment guaranteed hereunder at the rate equal to the three months US$ LIBOR quoted on page no. 3750 of Telerate, 2 days before the date from which interest becomes effective, plus 1% margin, from and including the first day after the date of instalment in default until the date of full payment by us of such amount guaranteed hereunder.

(4) In the event that the BUYER fails to punctually pay the second Instalment guaranteed hereunder or the BUYER fails to pay any interest thereon, and any such default continues for a period of twenty (20) days, then, upon receipt by us of your first written demand stating that the Buyer has been in default of the payment obligation for twenty (20) days, we shall immediately pay to you or your assignee the unpaid 2nd Instalment, together with the Interest as specified in paragraph (3) hereof, without requesting you to take any or further action, procedure or step against the BUYER or with respect to any other security which you may hold.

(5) We hereby agree that at your option this Guarantee and the undertaking hereunder shall be assignable to the Bank of China Limited, Hubei Branch, 65 Huangshi Road, Wuhan City, Hubei 430013, the People's Republic of China...

....

(7) Our obligations under this Guarantee shall not be affected or prejudiced by any disputes between you as the SELLER and the BUYER under the Shipbuilding Contract or by the SELLER's delay in the construction and/or delivery of the VESSEL due to whatever causes or by any variation or extension of their terms thereof or by any security or other indemnity now or hereafter held by you in respect thereof, or by any time or indulgence granted by you or any other person in connection therewith, or by any invalidity or unenforceability of the terms thereof, or by any act, omission, fact or circumstances whatsoever, which could or might, but for the foregoing, diminish in any way our obligations under this Guarantee.

...

IN WITNESS WHEREOF, we have caused this Letter of Guarantee to be executed and delivered by our duly authorised representative the day and year above written."

[JEB/mlm]

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